How Can Advisors Build a More Modern Portfolio?

SmartStops comment: The fear of investing in traditional assets due to volatility can be minimized for an advisor’s clients by the use of a SmartStops methodology. SmartStops was created because of the need for a more Modern Portfolio approach that could better manage traditional assets.

How Can Advisors Build a More Modern Portfolio?

Following a pair of bear markets, advisors know the days of buy-and-hold investors with 60/40 portfolio allocations are over.

From the mass affluent to the ultra-wealthy, investors want more than just equities and fixed income in their portfolios. Clients expect their advisors to bring innovative alternative investments to the table.

“A lot of investors and advisors have moved their assets to cash or into lower yielding asset classes,” said David L. Giunta, the president and chief executive officer of Natixis Global Asset Management’s U.S. distribution. “To get them off the sidelines, advisors can’t just bring these clients back to traditional approaches. There is just too much volatility.”

According to the 2012 Natixis Global Asset Management U.S. Advisor survey, the global financial crisis and uncertain market recovery has accelerated interest in alternative investing. According to the survey, 49% of advisors are uncertain that the traditional 60/40 allocation between stocks and bonds is still relevant, and 23% said the traditional approach isn’t close to meeting the needs of investors in contemporary markets.

But if a 60/40 allocation is no longer relevant, what is the right mix?

Dick Pfister, an executive vice president and managing director of global sales and consulting at Altegris Investments, A La Jolla, Calif., based provider of alternative investments, said modern portfolio theory has shifted dramatically in the past decade. He said that large institutional investors and endowments have “dramatically” increased their allocation to alternative investments.

According to a national study of endowments by the National Association of College and University Business Owners, the average endowment had 52% of its portfolio investments in alternative assets in 2010, up from 24% in 2002.

Pfister said he doesn’t expect advisors to shift their portfolios that dramatically, but anywhere from 10% to 35% of an individual investor’s portfolio should be held in alternatives.

“We are seeing a lot more on the upper end of that range,” he said. “With more mutual funds trading like hedge funds, more people are allocating to the alternative space.”

Giunta said clients are getting more comfortable with alternative investing because more alternative options are available within the comfortable and familiar confines of a mutual fund, but he says the right portfolio allocation varies on a client-by-client basis.

“We have to create portfolios based on each risk and volatility scenario,” he said. “Advisors need to talk to their clients and understand how much of a dip they can stand. Advisors need to be having those conversations and educating their clients about a variety of alternative options.”

Tim Clift, the chief investment strategist for Envestnet, a Chicago-based provider of technology-enabled wealth management products and services for advisors, said he thinks the average portfolio should allocate 20% to 25% to alternative investments. “Investors need to be putting a meaningful amount into alternatives,” he said. “Five percent to 10% is not meaningful enough to provide advisors and investors the proper downside protection.”

Robert Worthington, the president of Hatteras Funds, agreed that a 5% allocation was far too small. He said he worked with one advisory firm’s allocation committee that recommended 7% to 10% be put into alternatives and he told them, “if you don’t do 20% its not worth it.”

Hatteras, a Raleigh, N.C., based asset manager that provides alternative investment solutions for advisors and their clients, recommends 20% to 25% of a client’s portfolio be allocated to alternatives, Worthington said.

“More leading edge advisory firms are shifting 30% of their portfolio to alternatives,” he said. “I think others [advisors] are going to follow. With the advent of liquid alternative funds, advisors can increase allocation to alternatives without reducing liquidity. Access to alternatives to greater and easier today than it was four years ago and that means allocating to alternatives is becoming more mainstream.”